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LONDON (Reuters) - Britain's insurers will lose control of a market worth 15 billion pounds ($25 billion) a year under a surprise pension reform announced by the government, and will struggle to make up the hit to profits any time soon, according to analysts.

Finance minister George Osborne unveiled a far-reaching shake-up of the pensions system in his annual budget on Wednesday aimed at boosting choice and returns for pensioners who have seen their incomes hit by record low interest rates.

For the first time, all retirees will be free to do what they want with their pension pots, scrapping a system that made it compulsory for most of them to buy an annuity, where they exchange pension savings for a regular income.

This dismantles a captive market for annuity providers such as Legal & General and Resolution, which will now have to compete for pensions business against other investment products. Their shares dropped sharply on Wednesday, and analysts see little prospect of a rapid recovery.

According to Bernstein Research, about 75 percent of retirees purchase an annuity, with current rules obliging them to do so if their retirement savings are between 18,000 pounds and 310,000 pounds.

After the reforms, the annuity market for individuals could shrink by up to half, the firm forecast.

"There is a negative implication for new business flows in the individual annuity market, as some people utilise the increased flexibility provided by the ... (government's) proposals," Resolution said in a statement on Thursday.

RBC analysts said Legal & General (L&G) was the most exposed to annuities of the British insurers it covers, with its retirement division providing 29 percent of group cash in 2013.

L&G generated a net 1 billion pounds of cash in 2013.

QUICKER THAN EXPECTED

Many large annuity providers said they could benefit from the changes in the pension rules, pointing out that the government's budget was designed overall to offer incentives to savers, and more saving would boost the fund management and investment businesses run by the same companies.

Big life insurance groups Aviva, L&G, Prudential and Standard Life all run large asset management arms, which will also be likely to take in much of the pension cash that would have gone automatically into their annuities.

But analysts at credit rating agency Fitch, which estimates the annuity market is worth 15 billion pounds a year, said less new annuities business could mean lower profits.

"Companies offering alternative products for pensioners to manage and access their pensions would benefit. But we believe these products would typically generate lower profits than annuities," they said in a research note.

Most exposed are likely to be specialist insurers such as Just Retirement and Partnership Assurance, both of which offer so-called enhanced annuities to people with lower life expectancy.

"These two companies have grown fast, taking a large share of the rapidly developing market for enhanced annuities. The proposed reforms could seriously threaten their growth prospects and potentially lead to a significant reduction in their business," the Fitch analysts said.

The enhanced annuities market represented 28 percent of all annuity purchases in the last three months of 2013, up from 2 percent in 2003, the Association of British Insurers said.

Partnership Assurance shares halved in value on Wednesday and were down a further 9 percent on Thursday. Just Retirement stock was down a similar amount, having also plunged on Wednesday.

"A lot more people may not take annuities, I have to accept there's a reasonable likelihood of that," said Rodney Cook, Chief Executive of Just Retirement, in an interview with Reuters on Thursday.

Cook said the company was exploring new strategies and products to compensate for the expected drop in business from annuities and would update shareholders when Just Retirement publishes a trading update in May.

Insurers had been expecting some reform to annuities. With about half of retirees last year buying an annuity with a pension pot of less than 20,000 pounds, and annuity rates having fallen by a half over the last 15 years, they currently offer a very low income for most people.

"In theory, this is a logical step," said one industry insider at a large insurer of the reforms, speaking on condition of anonymity.

"But is it quicker than anyone expected? Well definitely. Is it what people forecast would happen straight away? No."